Boston Leads in Hedge Funds

SEC filings show Boston is a leader in hedge funds

By Ross Kerber, Boston Globe Staff April 21, 2006

New federal filings show that Massachusetts financial firms help manage more than $150 billion in hedge funds and other private investments, about 10 percent of the $1.5 trillion that the Securities and Exchange Commission estimates is held in private funds nationwide.

The filings, many available for the first time under new SEC rules that require hedge fund advisers and other managers of private funds to report data to the government, shed only a little light on this fast-growing, lucrative, and secretive corner of the world of money management.

While regulators couldn't provide figures showing where Massachusetts ranks compared to other states, the filings show that Boston is a major center of private investment.

''Boston has historically been one of the largest players in the hedge-fund industry, because the city has a tremendous pool of talented managers in the financial-services sector," said Richard A. Goldman, coleader of the hedge fund practice group at law firm Bingham McCutchen.

Scott Stewart, a Boston University finance professor, says hedge funds are a natural step for a local financial-services sector that began with insurance companies, then progressed to mutual funds and money-management. ''The hedge-fund business is a natural outgrowth of the firms that are here, and their people who leave to set up their own firms," he said.

Much of the money is tied to traditional financial-services companies including Bank of America, mutual-fund giant Fidelity Investments, and money-manager Wellington Management Co.

Private funds appeal to these firms because ''That's where the money is," said Lou Harvey, president of Dalbar Inc., a Boston market-research firm.

Compared to traditional mutual funds sold to the public, hedge funds and other types of private funds often are available only to wealthy clients and charge much higher management fees, frequently around 20 percent of profits. They're also more free to make risky bets such as short-selling stock.

The term ''hedge fund" isn't officially defined, but has come to refer to private investments made outside of some SEC public-disclosure rules. Other types of private funds can include those that take on debt to buy companies or private-equity firms that invest in assets like real estate.

The first hedge fund was created by New York manager A.W. Jones in 1949, who used a combination of short-selling and borrowing to protect, or hedge, against risks that individual stocks or the whole market would decline.

Many hedge funds have taken on much chancier strategies since then to capture higher returns. They exploded in popularity during the 1990s despite debacles like the near collapse of Long Term Capital Management in 1998. Since last year leaders of Connecticut hedge-fund operator Bayou Group have pleaded guilty to swindling $450 million from investors. Another hedge fund company, International Management Associates in Atlanta, has been closed amid complaints clients have lost millions of dollars.

Despite these cautionary tales, the hedge-fund industry worldwide has almost tripled to nearly $1.4 trillion in assets under management from $470 billion in 2000, according to research service Lipper Tass.

Locally, some of the biggest names in Boston investing have gotten into hedge funds: in February, news reports citing unidentified people said former Harvard endowment chief Jack Meyer had raised a record $6 billion for his new hedge fund firm, Convexity Capital Management LP. (A representative there said rules prevented the firm from commenting.)

Aiming to get a firmer handle on hedge funds' workings, the SEC put a rule into effect in February that requires private-fund advisers to disclose more information about themselves and the funds they work with. The rule still faces critics such as Republican SEC Commissioner Paul S. Atkins, who recent told a Boston University audience the disclosures do little to protect investors but burden both regulators and the industry. One weakness is the absence of a formal SEC definition of what is a hedge fund.

But the filings at least provide a window into how deeply some of Boston's most prominent firms have gotten into the private fund universe.

Altogether 115 Massachusetts companies or advisers have told regulators they help run private funds in some respect, as of Feb 28, according to data provided by the SEC. Its figures show Bank of America is the largest adviser of private fund assets registered in Massachusetts, with around $30.5 billion. (Bank of America says the total is now higher, more than $35 billion).

Money-manager Eaton Vance was second with $26.4 billion, followed by Wellington with $10 billion, and Adage Capital Management LP, run by former leaders of Harvard University's endowment, with $7.7 billion. Divisions of money-manager Grantham, Mayo, Van Otterloo & Co. were listed with a total of $19.8 billion.

Units of other major players like Massachusetts Mutual Financial Group and Pioneer Investments also appear. SEC officials caution the data may be out of date if companies have done more recent filings, or limited for other reasons such as overlapping accounts.

Of the more than 15 companies contacted for this article on the list, most either didn't respond to messages or said they couldn't comment because of SEC rules prohibiting them from advertising their products.

Others were more open. A Bank of America spokesman, Tom Gariepy, said the largest amount of its private-fund money, $31.5 billion run by its Columbia Management Advisors LLC unit, invests mainly in short-term bonds as part of the bank's money-market operations. Another unit, Banc of America Investment Advisors Inc., offers wealthy investors the chance to invest a combination of different hedge funds, an approach known as a ''fund of funds" strategy.

Filings show the Banc of America division solicits its clients to invest in private funds like one called ''BACAP Multi-Strategy Hedge Fund Ltd.," which requires a minimum investment of $500,000.

Eaton Vance spokeswoman Meg Pier said the $26.4 billion figure double-counts much of the money handled by the company's Boston Management and Research unit, whose total of private funds is $13.5 billion. Many of these funds are in turn pooled into one fund totaling $12.9 billion, which represents the majority of Boston Management and Research's assets, she said.

She called the funds ''pooled investment vehicles offered privately to high net worth investors and certain institutional investors." Compared to mutual funds, the private funds' advantages can include more flexible investments and better tax treatment, she said.

Private fund assets totaling $1.5 billion are associated with Fidelity units on the SEC's list. One unit, Geode Capital Management LP, helps run $646 million, according to filings. Fidelity spokeswoman Anne Crowley said the unit ''uses alternative investment strategies, including long-short management techniques."

A hedge-fund industry primer

Some terms for understanding the hedge-fund industry:

PRIVATE FUND -- Investment funds subject to less oversight. The federal Investment Company Act of 1940 regulates companies that offer investment products, such as mutual funds, to the public, but it exempted some funds from regulation, such as those with fewer than 100 investors, or if member investors had substantial money invested elsewhere.

HEDGE FUND -- Not defined by SEC regulations. In practice the term often refers to a private fund that isn't publicly marketed and in which the manager earns a ''performance fee," or a share of the fund's profits, often as much as 20 percent. By some estimates the industry now accounts for around $1.4 trillion among 8,000 funds.

FORM ADV -- To fight fraud, a new SEC rule adopted in 2004 ended exemptions and required many hedge-fund advisers and others to take steps such as filing data about themselves using the form ADV and to appoint a chief compliance officer.

ACCREDITED INVESTOR -- Under SEC rules, these include a person making more than $200,000 a year, or a couple making $300,000 a year, or a couple whose net worth exceeds $1 million. Many hedge funds and other private funds require investors to meet these minimums.

SOURCES: Securities and Exchange Commission, Lipper Tass

Ross Kerber can be reached at kerber@globe.com.

Hedge Fund Milestones

Hedge-Fund Milestones
January 29, 2007 WSJ

Hedge funds, investment vehicles for the wealthy and institutional investors, have proliferated in recent years. When Long Term Capital Management collapsed in 1998, the industry had about $240 billion under management. In contrast, by the end of 2006, the industry had about $1.4 trillion under management, according to Hedge Fund Research, Inc., a private firm in Chicago. Though they control just 5% of all U.S. assets under management, they account for about 30% of all U.S. stock-trading volume. But the industry's rise hasn't always been smooth. Here are some key milestones for hedge funds since 1995.

June 1995-- Highlighting the difficulties faced by many hedge funds in the mid-1990s, Bruce Kovner, a legendary currency and commodities speculator, disbands his U.S. fund and returns about two-thirds of the $1.8 billion he managed at Caxton Corp., founded in 1983. Caxton had averaged annual returns of at least 30% for most of its existence, but lost money in 1994 and was struggling again in 1995. Caxton's troubles weren't unique: Hedge funds' total assets under management shrank for the only time in industry history in 1994. Analysts blame rising interest rates and the industry's unwieldy size after a 1991-93 growth spurt.

October 1995-- An even more shocking closure follows a few months later, when Michael Steinhardt shuts down his $2.6 billion investment partnerships. Mr. Steinhardt's decision came despite the fact that he had enjoyed good returns in 1995 after a disastrous 1994. Mr. Steinhardt, known for his aggressive, short-term trading and big, risky market bets, started his fund in 1967 and was a pioneer of the industry. His average annual returns of 30% or more helped his assets under management balloon to $4.4 billion at their peak.

January 1997-- Odyssey Partners, one of Wall Street's most successful private investment partnerships, dissolves because the $3 billion hedge fund has grown too bulky to easily invest.

June 1997 -- Another legendary manager, Julian Robertson Jr., hoping to profit from the rising prices of mutual-fund and asset-management companies, puts a chunk of his Tiger Management Co. on the block.

September 1997 -- George Soros, founder of Soros Fund Management LLC, one of the world's largest hedge funds, is accused by Malaysian Prime Minister Mahathir bin Mohamad of bringing down the Malaysian currency, the ringgit, during the Asian financial crisis.

September 1998 -- After spectacular early success, Long Term Capital Management, a fund founded in 1994 by John Meriwether, the former head of bond trading at Salomon Brothers, faces a cash and credit crunch after a series of bad investments. The fund nearly collapses, but a consortium of Wall Street firms, including Goldman Sachs & Co., puts up $3.6 billion for a bailout.

October 1998 -- Hedge-fund operator Everest Capital Ltd., headed by Marko Dimitrijevic, loses nearly half of its $2.7 billion under management. Financier Nelson Peltz and several college endowments, including those of Yale and Brown universities, are hurt.

December 1998 -- A disastrous year for the industry comes to a close. In addition to the LTCM and Everest debacles, Mr. Robertson's gains for the year were wiped out in the last quarter, and one of Mr. Soros's funds lost 18%. The average hedge fund focused on U.S. stocks returned 12.7%, less than half the 28.6% gain of the S&P 500. Many other hedge-fund categories produced gains in the low single digits, while several categories racked up losses for investors.

March 2000 -- Tiger Management LLC, a $6 billion hedge-fund, announces it will close down most of its operations and liquidate its investments. Mr. Robertson, Tiger's chief, blames the stock market's rush to Internet stocks. Meanwhile, throughout the year, Soros Fund Management struggles with losses as its attempt to venture into tech stocks fails and several people quit, including chief investment officer Stanley Druckenmiller. Mr. Soros vows to stick to more conservative investments.

October 2001-- Charles Schwab Corp., the top U.S. online and discount broker, announces plans to start offering hedge funds to its clients in the next year.

December 2001 -- Though hedge funds now control more than $500 billion in assets, most saw mediocre results for the year, with average returns of 3.2%. The Sept. 11 attacks, a vacillating stock market and a lack of deal-making are key reasons for the weak returns.

January 2003 -- A new breed of hedge funds, which have a reduced minimum investment requirement, are gaining popularity. Most traditional hedge funds require investments of $250,000; but new funds such as Oppenheimer Tremont allow affluent individuals to invest as little as $25,000.

May 2003 -- The research firm Strategic Financial Solutions LLC estimates that there are about 4,100 hedge funds in existence, with about $450 billion in assets.

September 2003 -- The SEC recommends regulations for the hedge-fund industry, including a requirement that managers register as investment advisers and be subject to occasional audits.

July 2004 -- Hedge funds, looking for other places to put their money, are increasingly competing with private-equity funds to provide capital to ailing companies. Perry Capital, an $8 billion hedge fund, gave $100 million revolving line of credit to the energy company, Xcel Energy Inc. Hedge funds are also becoming prominent in acquisitions. A group of a dozen hedge funds makes it into the final round of bidding for the Texas Genco Holdings Inc. unit of CenterPoint Energy Inc., but loses out to two big-name private equity funds: Blackstone Group and Kohlberg Kravis Roberts.

November 2004 -- Assets under management by hedge funds reach a record $1 trillion. They have grown 20% a year, on average, since 1990.

May 2005 -- Citigroup Inc. announces it is forming a joint venture with Pacific Alternative Asset Management Co. to offer hedge-fund portfolio-management services to its wealthiest clients.

August 2005 -- Greenwich, Conn. becomes the unofficial hedge-fund capital with more than 100 funds. Greenwich-based hedge funds collectively manage more than $100 billion, about a 10th of the total invested in hedge funds world-wide.

August 2005 -- Bayou Management LLC, a $440 million hedge fund based in Stamford, Conn., closes down without returning investor money. The founder, Sam Israel III, is accused of overstating gains and understating losses.

February 1, 2006 -- The SEC's registration requirement takes effect.

June 2006 -- Amid a tumultuous stock market, several hedge funds shut down, and others suffer. KBC Alternative Investment Management, for example, drops from $5.3 billion in assets to less than a $1 billion in 18 months. But the problems appear well-contained.

June 2006 -- The Court of Appeals for the District of Columbia Circuit vacates the SEC rule requiring hedge-find advisers to register with the agency, calling it "arbitrary." The decision is a major victory for the $1.2 trillion hedge-fund industry and forces the SEC to find another way to monitor it. By early December, some 275 hedge-fund advisers withdraw from SEC registration.

August 2006 -- One of the biggest New York hedge funds trading natural-gas futures, MotherRock, shuts down after suffering big losses in the natural-gas market in June and July.

September 2006 -- Connecticut hedge fund Amaranth Advisors, despite boasting of world-class risk-management systems, loses $5 billion in one week on a natural-gas bet gone wrong, cutting its assets under management in half. Days later, after losing another $1 billion, Amaranth agrees to sell its energy portfolio to J.P. Morgan Chase and Citadel Investment Group. By the end of the month -- after talks with Citigroup about a possible purchase of assets break down -- Amaranth says it will liquidate all its positions, marking the end of one of the most spectacular collapses in industry history.

November 9, 2006 -- Fortress Investment Group files plans with the SEC for what would be the first initial public offering of shares by a hedge-fund firm in the U.S. In January 2007, underwriters set terms at 34.29 million shares with an estimated price range of $16.50 to $18.50 a share.

November 28, 2006 -- Citadel Investment Group says it plans to sell $500 million in bonds, the first stage in what could be up to $2 billion in debt issuance and one of the largest offerings from a hedge fund in the investment-grade corporate-bond market.

December 2006 -- The SEC proposes raising the net worth investors must have to invest in a hedge fund to a minimum of $2.5 million in investments from $1 million in net worth, a step aimed at protecting individual investors.

January 26, 2007 -- Hedge funds are increasingly borrowing shares1 to influence the outcome of company votes, The Wall Street Journal reports.